Monday, April 2, 2012

I have written extensively about what it takes to become a good quantitative analyst. It isn't just about knowing the right technique or writing a better algorithm, though that is part of the skill set needed. What's more important is situational awareness - awareness of the investment environment that we live in so that we can deploy the right model to take advantage of the environment.

To illustrate my point, if you are in the New York area on April 16, 2012, I would strongly suggest attending the QWAFAFEW evening with Sam Eisenstadt. Here are the details:

My Life as an Empiricist: a Conversation with Samuel Eisenstadt,The stock market, its information, and the tools available to track and analyze it were far more limited during most of Sam's 63-year tenure at Value Line than they are today. This conversation, in Q &A format, will explore the development of analytic tools, ranking systems, and indexes with a special focus on the Timeliness Ranking System. Other subjects will include capital market and market data observations over the years and interactions with luminaries such as Louis Rukeyser, Fischer Black, Rex Sinquefeld, Peter Bernstein, and more.

The questions will be posed by Herb Blank - formerly of Value Line, Deutsche Bank Securities, and Rapid Ratings. If you have any questions, you wish Herb to pose to Sam, please e-mail them in advance to hblank@qwafafew.org. (Please note that questions about the management of Value Line and its operations are strictly off limits and will be considered Grounds for Immediate Departure.)

Here is Eienstadt's biography [emphasis added]:

From 1946 through early 2010, Eisenstadt worked with just one firm - Value Line, publisher of the Value Line Investment Survey. Hired as a proofreader after serving in the European theater during World War II, Sam moved over to research in production in 1948, then became the firm's Director of Statistics, and eventually ascended to Research Chairman. There he played a major role in developing the Value Line Timeliness Ranking System - referred to by many as the industry's first practical quantitative model for stock selection - and took charge of its weekly production. In 1971, the late Fischer Black wrote in the Financial Analysts' Journal that the Timeliness Ranking System was the one provable anomaly to the Efficient Market Hypothesis that he had found to-date. Never satisfied with past accomplishments, Sam continued to work on improving the Timeliness Ranking System while also developing a Technical Ranking System along. Other developmental work included various asset allocation models and indexes. Personal highlights include a debate with Professor Rex Sinquefeld and appearances on Wall Street Week with Louis Ruykeyser. One common thread is that everything Sam developed was data-driven, preferring to let the data speak for themselves rather than super-impose pre-conceived theories upon them. Sam holds a bachelor's degree in Statistics from the City College of New York.

Eisenstadt is a quantitative pioneers. He was a major force in the implementation of the Value Line Timeliness ranking system - which is used as proof by counterexample that the strong form of EMH does not hold. Yet the title of the talk is "My life as an empiricist", an illustration that it takes more than just an advanced degree in the hard sciences to be a quant.

If you only have a hammer, then every problem looks like a nail
The real value of a quantitative technique is in its application, but when do you know to apply it? For most quants, who just know about techniques but lack in-depth market experience, the issue becomes one of the carpenter armed with a hammer. Every problem looks like a nail.

Consider, for example, the €conomia game that the Trichet ECB unveiled in late 2010 to explain its approach to monetary policy. Matthew Yglesias explained it this way [emphasis added]:

The game embeds a number of assumptions I would disagree with, but that seem telling. Short-term interest rates are your only policy tool. And their view of the transmission mechanism seems to be that inflation in QN is jointly determined by the change in inflation rate between QN-1 and QN-2 and the level of real output growth in QN-1. But a change in interest rates affects output immediately. So if the inflation rate is rising, whether because of demand-side or supply-side factors, the only way to prevent it from spiraling out of control is to raise rates enough to reduce real output. If inflation is plugging along at your target level, then bad weather causes crop failures and food prices go up and output goes down, you need to raise interest rates. If you don’t raise rates, then what happens is that inflation momentum pushes inflation up further in the next quarter and then the hit to output fades away which further increases inflation. Then since there’s even more inflation built into the system, you need to undertake a bigger rate hike down the road to drive output growth down enough to get inflation under control.

Long story short, the only responsible thing to do is to prophylactically raise rates in the face of adverse supply shocks. It shouldn’t stun us that this is what the game says, since it’s how the ECB behaves in practice. But the consequences have been disastrous in practice and I’m not sure what theoretical support they think they have for this view of how the world works.

I have no doubt that the ECB is full of economists with advanced degrees who are much smarter than I am. But do then have real-life experience?

If your only tool is interest rates, then every inflation shock looks like a nail. The Trichet ECB seemed to view the world through this lens. Here's Yglesias' view of the game as reflective of the Trichet ECB's attitude:

That’s the ECB’s view of the world. Output doesn’t matter. Unemployment doesn’t matter. Having inflation close to 2 percent matters a little. But it matters more to be below 2% than to be close to the target. If forced to choose between full employment and 4.16% inflation and a years-long deflationary recession, choose the recession.

On the other hand, Mario Draghi has been more pragmatic, though his approach is fraught with risks.

Experience + Technique = Creativity and Good Analysis
Canada's Globe and Mail recently featured an article that addresses this issue entitled How can universities teach students to think creatively? The key is experienced based learning and figuring out how to apply what you learned to a problem [emphasis added]:

How can universities – key players in the process – teach students to think critically and creatively? Arvind Gupta thinks he has the answer.

Dr. Gupta is a computer science professor at the University of British Columbia and chief executive and scientific director of Mitacs, a national government-funded research organization that runs an internship program for Canadian graduate and postdoctoral students. The program brings together companies with students who help the organizations solve their research challenges. Dr. Gupta also sat on the federally-appointed Jenkins task force that recently completed a review of federal spending on research and development programs headed by Open Text Corp. chairman Tom Jenkins.

Dr. Gupta spoke to The Globe and Mail about how universities strive to foster creativity in their students, how Mitacs plays a key role in the process.

Q. Do universities stifle creativity in students, or the opposite?
A. I think there's lots of challenges in an education system that's got to be very broad based and has to both train young people for existing jobs and for future jobs. We're trying to train people to be creative because they have to be very flexible in the kinds of jobs they might take on. We need to think about what the economy of the future will look like and what kinds of skills are easily transferable and there, at least I like to believe, we try very hard at universities to think about those kinds of issues.

Q. How can universities foster creativity and innovative thinking?
A. I'm a big believer in experiential learning. I think that in our university system we should engage society much more in the training of young people. I like co-op programs. I think they help give focus to more theoretical knowledge. At Mitacs we run programs where we get graduate students to go into society and look for emerging research challenges. We get young people talking to companies about what kinds of challenges these companies are seeing.

Q. Can you tell me a bit about how Mitacs does that?

A. For the more junior graduate students, Mitacs has staff that talk to companies about their challenges and then we bring a student and professor in to articulate clearly what the problem is. Then the student spends part of the time at the company. Seeing the problem for yourself is very different from having someone explain it to you. So we get the student to go to the company site, understand the problem first-hand, and then spend time tapping all the creative minds at the university on all the different possible ways to solve it. To me that's really the best way to stimulate creativity.

In other words, university training isn't just about talking someone to be book smart. It's also about teaching someone to be street smart.

When you are only book smart, you get the Trichet ECB. When you are both, you get innovation and creativity. That's what happened with Sam Eisenstadt.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

I saw a parallel this weekend on Fareek Zakaria's CNN show wherein Neil DeGrasse Tyson makes the argument that by increasing NASA funding from 1/2 to 1% we could stir innovation that has been lapsing in recent decades, and would eventually seep into our private sector.

Similar to Dr. Gupta's ideas, some are proposing blended style concept learning models e.g., Khan Acdemy which can identify and measure via computer in real time for students and teachers, wherein these concepts can be realised more quickly. As an aside my wife will be going the experiential route via Qingdao China in April as the beginnings of a student/teacher exchange.

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

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None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.